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How to Invest in Real Estate With a Self-Directed IRA: Is It The Best Option?

Real Estate With a Self-Directed IRA

In a standard IRA (or 401(k)), your investing options are limited to publicly traded assets like stocks, bonds, mutual funds, and ETFs. Those limits are lifted when you choose to invest instead in a self-directed IRA or a self-directed 401(k).

With the self-directed option, you can invest in “alternative” assets like real estate, precious metals, privately held companies, and yes, cryptocurrency. Today, Jonathan from Parent Portfolio will be discussing the real estate option.

Personally, I have not opened a self-directed IRA or 401(k), but I’ve been tempted to open the 401(k) version for two reasons. One, a custom plan that happens to be a self-directed 401(k) is what I would need to be able to do the megabackdoor Roth annually. Second, it would be a great place to hold something like the DLP Lending fund, a tax-inefficient real estate fund that pays interest taxed at ordinary income tax rates. I currently own it outside of a retirement account where tax drag is a real issue.

Typically, I recommend holding equity real estate outside of retirement accounts — there can be excellent tax benefits that won’t be realized inside a retirement account — but any interest-paying (think debt-based) real estate investment would be an excellent candidate for a self-directed IRA or 401(k). Jonathan, tell us more!



How to Invest in Real Estate With a Self-Directed IRA: Is It The Best Option?


Real Estate With a Self-Directed IRA


Are you looking to diversify your portfolio beyond stocks, bonds, mutual funds, and ETFs? Or, are you a rookie investor interested in leveraging money in your retirement account because a real estate guru mentioned the words “self-directed IRA real estate?”

Real estate can be a powerful vehicle to build wealth and financial independence. However, it’s essential to understand the rules before you start looking to purchase a real estate property. IRAs have strict regulations, primarily when investing in real estate with a self-directed IRA.

Is investing in real estate with a self-directed IRA a bad investing strategy? Every investor is different, and after reading this article, you may find that it may or may not be a viable option for you. However, what may be a sound decision today may change in the future.

If you asked me ten years ago if I wanted to be a landlord and invest in real estate, I would quickly tell you no. However, years later, I changed my investing strategy and began owning real estate properties every six to seven months.


What is a Self-Directed IRA?


A standard Individual Retirement Account (IRA) has two main options: a Traditional IRA and a Roth IRA. Both options provide tax benefits that a person can withdraw from after 59 ½ without penalty.

A Traditional IRA allows a person to defer paying taxes on their contributions and investments after withdrawing. On the other hand, money contributed to a Roth IRA has already been taxed and thus can be withdrawn tax-free.

Some prefer the Roth IRA option because it allows them to avoid a higher tax bracket when they withdraw from their retirement account. However, most brokerage firms that manage these kinds of IRAs only invest in the stock market, such as mutual funds, bonds, ETFs, etc.

For this reason, a self-directed IRA allows people to invest in other things beyond stocks, such as non-publicly traded start-up companies, precious metals, and in particular real estate. A person can use a self-directed IRA to purchase rental properties, land, house flipping projects, and conduct wholesaling deals.

To fully take advantage of the tax benefits that a self-directed IRA provides, an account holder must fund all real estate transactions from the IRA, also known as an “arms-length transaction.”  Therefore, they can not pay any expenses out-of-pocket and cannot work on the property themselves (i.e., sweat equity). Instead, they have to use the IRA to pay for all expenses and hire a third-party to perform improvements.

Furthermore, any rental income generated from an investment property or profit made from a sale must go back into the IRA. An investor can then reinvest the newly acquired retirement funds in another real estate deal. However, the tax code prohibits withdrawing until the appropriate age without penalty.


How to Setup a Self-Directed IRA for Investing in Real Estate


Some brokerage firms may not offer a self-directed IRA. It can be counter-intuitive for a brokerage firm to promote diverting funds out of the stock market. Instead, you’ll have to find a financial institution or company that permits self-directed IRAs. This financial institution is known as an IRA custodian.

The best way to find an IRA custodian that offers self-directed IRAs is by networking with other real estate investors. Successful real estate investing is built upon making relationships with others. You can easily connect with them at local real estate meet-ups or online, such as BiggerPockets, for them to provide you their recommendations.

However, be sure to verify how much the fee the custodian will charge. Some custodians charge a flat fee, while other custodians charge a percentage of the real estate asset’s value.


What Does a Custodian Do?

The custodian is responsible for record-keeping any real estate transactions related to the IRA and reporting them to the Internal Revenue Service (IRS). They are not responsible for finding you good real estate deals, screen tenants, nor calculating fair market rents. Instead, their purpose is to ensure that all transactions adhere to the IRS rules to qualify and avoid any taxable events.

Furthermore, a custodian will be the one to sign off on any transactions, such as a lease agreement with a tenant or a mortgage to finance a property. The value of the property also needs to be reported to them annually.


Managing an IRA Through an LLC

Anytime you want to perform a transaction out of a self-directed IRA, you must first consult the custodian for approval. This process can impact how and when you perform deals. In real estate, sometimes it’s prudent to be first!

A solution to this problem is creating a limited liabilities company (LLC) that the IRA invests in. You can assign yourself as the LLC manager and move the checkbook’s control from the custodian to you. You will gain the power to decide how and when you want to do deals.


Benefits of Using Self-Directed IRA to Invest in Real Estate


Tax Shelter

One of the main benefits of an IRA is its tax shelter. Investors can defer paying tax on any cash flow from rental properties or any profit made from a house flip sale. The goal is similar to a self-directed Roth IRA. However, contributions are already taxed, but withdrawals are tax-free.


Potential for Higher Returns

The stock market can fluctuate from year to year. In contrast, real estate is a tangible asset, which has shown to be more stable historically. The cash flow from a rental property, especially a multi-unit, can yield higher returns than the stock market.

However, not every real estate investment is equal. Although self-directed IRAs allow people to invest in real estate, it is still the investor’s responsibility to do their due diligence, such as estimating monthly expenses and calculating the cash on cash return.

I've got my 2 acres of non-leveraged, crop-producing, cashflowing farmland via AcreTrader. Get yours.


Restrictions and Drawbacks of Using Self-Directed IRA


The IRS has prohibited transaction rules when it comes to investing with a self-directed IRA. Any violation can disqualify an investment and make it become a taxable event. Here are the things to be mindful of when investing in real estate.


Lack of Liquidity

Real estate is an illiquid asset because it cannot quickly liquidate into cash, unlike stocks. Also, you cannot sell real estate properties in separate parts.

Therefore, if you need money immediately, real estate is not the ideal solution. It can take weeks or months for a seller to close on a property.

Additionally, if you withdraw from your IRA before 59 ½, you’ll receive an early withdrawal penalty, which is a 10% of how much you take out from your IRA. On the other hand, at the age of 70 ½, you have to start withdrawing the required minimum distributions.


No Sweat Equity Allowed

With regular real estate investing, such as buy & hold real estate investing and house flipping, investors have the option to make repairs themselves. This option allows investors to save on labor costs by doing it themselves, such as painting or installing floors.

However, a self-directed IRA prohibits an account holder from performing any improvements or repairs on an investment property. An investor has to hire a third-party to perform any work and pay them from the IRA.


Contribution Limits

The IRS requires that the IRA fund all real estate transactions. This situation can become problematic if there isn’t enough money available in the IRA to cover expenses.

According to the Internal Revenue Code for 2021, a person’s max contribution is $6,000. Some big-ticket items can easily exceed that amount, such as replacing a roof or furnace.

Therefore, an investor must do proper analysis when selecting a property. They should account for unforeseen expenses and reserve that amount within the IRA.


No Family Members Involved

The real estate property acquired by the self-directed IRA cannot be for personal use, such as a primary residence or a second home. You cannot even “house hack” and live in one of the duplex units because you’re a disqualified person.

Additionally, certain family members cannot be involved in any transactions, such as buying real estate, selling it, and living at the property. Otherwise, the investment would become disqualified. The prohibited family members are spouse, parents, grandparents, children, grandchildren, and their spouses.


Lack of Ownership

Although an investor is a self-directed IRA holder, the owner of an investment property is the IRA. Therefore, the IRA owner cannot claim certain tax deductions, such as property tax and depreciation.


Getting a Mortgage With a Self-Directed IRA


Some banks allow an IRA to get a mortgage loan. However, it will be a non-recourse loan, which means that the bank can foreclose on the property and take it if the IRA ever defaults on its payments.

Also, the IRS will tax the amount the bank is financing as an unrelated business taxable income.  This tax is called Unrelated Debt-Financed Income Tax (UDFI).

For example, an investor purchases a property for $200,000. The IRA makes a 30% down payment, which is $60,000. On the other hand, the bank finances the remaining $140,000.

The IRS sees the $140,000 as non-IRA funds and thus will tax that amount. For this reason, investors usually avoid bank financing and fully fund a real estate purchase with the IRA.


Alternative Retirement Investment Option For Real Estate


Although a self-directed IRA can provide an opportunity to invest in real estate and have a potentially better return, the number of restrictions and drawbacks should caution you from moving forward.

However, if you’re still adamant about leveraging your retirement accounts’ balance to buy real estate, an alternative option is a self-directed 401k, also known as a Solo 401(k).

A Solo 401k is similar to a self-directed IRA but has fewer restrictions, making it a more attractive investment vehicle. For example, a Solo 401(k) has higher contribution limits, is exempt from unrelated business income tax, and an account owner can take out a personal loan.

Furthermore, the max contribution for a Solo 401(k) is $58,000 annually in 2021, unlike the $6,000 max contribution for a self-directed IRA. Also, a Solo 401(k )does not require a custodian allowing more control to the account owner.

However, the only catch with the Solo 401(k )is that you need to be self-employed. The IRS created it for small business owners. So, if you have a side hustle, this investment vehicle may be for you!





Real estate is a powerful asset that can produce sufficient passive income in your retirement years. However, it’s essential not to over-leverage yourself.

I recommend new investors in real estate keep their investing strategies simple. In general, investing is a marathon and not a sprint. Rome wasn’t built in a day, and nor is wealth!


I've got my 2 acres of non-leveraged, crop-producing, cashflowing farmland via AcreTrader. Get yours.


Have you opened a self-directed IRA or 401(k)? What investments do you hold in it?


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5 thoughts on “How to Invest in Real Estate With a Self-Directed IRA: Is It The Best Option?”

  1. Subscribe to get more great content like this, an awesome spreadsheet, and more!
  2. The part missing is that there isn’t always the option of using post tax funds instead of a sdira.
    The right question isn’t whether I should invest in real estate inside my ira or outside of it.
    If I only have investable assets inside my ira, the question is if real estate is a good investment for those funds.
    My sdira real estate investments compound tax-free, are inflation protected, and income producing.
    Yeah I wish I could depreciate and pay capital gain tax rates. But you use the tools you have in your tool bag.

  3. Im looking at opening a self directed solo401k for hard money loan investing, however I really dont want this type of investment to be more than a part of my solo401k and like the one I have at Vanguard. I am trying to see if I can still link my Vanguard funds to a self directed account—have some meetings coming up with them

  4. It’s funny because I saw a thread on Twitter yesterday about investing in real estate with an IRA and my mind was blown.

    This is a great post and highlights the positives and negatives of pursuing this option.


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